Asset Allocation January 15, 2008:

Welcome to 2008 so far the year has not been kind to equity investors and my concern is that the entire year may not be much better than the first 2 weeks. The credit market turmoil has not abated at all and in fact appears to be getting worse and could get a lot worse before it gets better. Today’s announcement by Citigroup that it is taking an $18 billion dollar write down on the subprime and collateralized debt portfolio is just one more huge write off and we will see many more massive write downs before this is over.

The problem for the financial services sector is that they are being forced to raise capital to shore up their balance sheets at the worst time in years. Shareholders are seeing their positions being eroded by the issuance of shares to cover off the impact of incredibly bad judgment by management. Anyone who owns financial shares is going to see a decline in value that may take years to recover. The housing bubble has burst and a real estate asset bubble has such a widespread impact on wealth that it takes years for the market to recover. I just read where the housing sector accounts for approximately 40% of the total wealth of individuals in the USA. It is then easy to understand why the US economy is slowing with house prices down an average of 7% nation wide and lots of potential for more declines.

I have been concerned about a recession in the US for over a year now pointing to the inversion in the yield curve as the main indicator. Well the yield curve has been inverted for 18 months now and there has never been a time in history when this has happened and the economy did not go in to recession. The bursting of the real estate bubble will only make the slow down deeper, more wide spread and longer lasting.

In anticipation of this type of economic scenario developing in the coming months I am recommending some changes to the Asset Allocation Model. In December the allocation was 50% equity, 20% bonds and 30% cash. Going forward this should be changed to 20% equity, 50% bonds and 30% cash. I believe the global equity markets will be entering a major bear phase this year that could last for 12 – 18 months; investors will have to be very selective when choosing stocks in order to avoid a substantial decline in portfolio value.

The 20% equity portion of the portfolio should be allocated in the gold, energy and agricultural sectors with a smaller portion in base metals, alternative energy and technology. Avoid financial services, home builders, forestry products, consumer durable, transportation and travel and tourism companies.

The regional allocation should remain, 30% Canada, 30% Asia, 20% Latin America, 10% Japan, 5% US and 5% Europe.

The bond allocation should be changed from all 1-3 year government bonds to 30% 1-3 year, 30% 4-7 year and 40% 20 year plus. The change is in anticipation of interest rates declining and credit spreads narrowing over the net 12-18 months, stay with Government bonds for now there is far too much uncertainty in the credit markets to move out the risk curve at this time.